Oil prices will swamp subprime as market driver

[Rajiv]

Oil prices will swamp subprime as market driver

Here's my fearless forecast for 2008: The subprime mortgage mess will be far less important to investors next year than the price of oil.

The reason is simple: We don't sell our homes once a week, but that's about how often we fill up our gas tanks.
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Also the Oil Drum Discussion on this

We see a three-pronged problem staring us in the face, which can be defined along the lines of Peak Oil, Peak Climate and Peak Money. And just like people interested in peak oil often also read a lot about climate issues, they increasingly read, and comment, about the credit crisis as well.

Therefore, we thought that Mr. Barnhart’s statement that in 2008 oil prices will trump the credit crunch, is a good way for you to let us know how you feel about all of this. First, about the focus on finance at TOD:Canada, and second, about the statement in question:

The subprime mortgage mess will be far less important to investors next year than the price of oil.

We don’t want to lead you too much, but we did do a little digging to provide a first impression. We restrict ourselves to the US in this case, since that is Mr. Barnhart’s home turf, but we might also have taken Canada, of course. It makes little difference for the overall picture.

To start off with, oil prices. We turned to the Federal Highway Administration for data on US gasoline consumption.

US Department of Transportation: Federal Highway Administration
Passenger cars and other 2-axle 4-tire vehicles
Motor-Vehicle Travel: (millions of vehicle-miles)

• 2005: 2,749,555
• 2004: 2,727,054

Number of motor vehicles registered

• 2005: 231,904,922
• 2004: 228,275,978

Average miles traveled per vehicle

• 2005 11,856
• 2004 11,946

Average fuel consumption per vehicle (gallons)

• 2005 601
• 2004 608

Average miles traveled per gallon of fuel consumed

• 2005 19.7
• 2004 19.6

Let’s put vehicle miles for 2008 at 2.800.000 million, or 2.8 trillion.
We can then calculate:

Total fuel consumption: 240 million vehicles x 600 gallon= 144 billion gallons.

Or, alternatively, 2.8 trillion vehicle miles/19.7 mpg= 142 billion gallons.

Let’s take the “high road” and make it 150 billion gallons.

Average US gasoline prices, as per the EIA, Dec.17, 2007, were pretty much right at $3 per gallon. Which means a total cost of $450 billion.

Now, let’s take a few possible price increases for 2008 and do the math:

Increase %	Increase $	New price	Total extra cost
20%	$0.60	$3.60	$90 billion
33%	$1.00	$4.00	$150 billion
50%	$1.50	$4.50	$225 billion
100%	$3.00	$6.00	$450 billion

Since most Americans shiver at the thought of even a $1 price hike per gallon, let’s be kind and take that as our starting point. This means an extra $150 billion will have to be forked over at the pump to keep driving the same way and distance. There will also be effects on food prices and other costs, but they are much harder to calculate, so for the sake of simplicity we have left them out.

The question then is: how does that $150 billion relate to the potential losses in what Mr. Barnhart calls the subprime mortgage mess? NB: we assume he means the overall credit crunch when he says subprime, since it’s becoming clear that subprime mortgages are but a part of the credit problem.

The price of a home a year from now is as hard to foresee as the price of a gallon of oil, and there are many different voices, as expected. So we go to the top, the Fed, and to a few “graphic graphs”.

[Guest]

Re: Oil prices will swamp subprime as market driver

Rajiv -

According to iTulip this high price of gas at the pump is merely a direct corrolary to the reduced purchasing power of the USD. Substantively, we apparently need only watch M3 to derive the future price of oil. If we resolve abuse of the currency, oil prices will behave.

[Guest]

Re: Oil prices will swamp subprime as market driver

"What the Oil Industry is Afraid to Tell You!"

As 2007 ends, oil is up in the mid-$90s. Its year-to-date average is $84.83, shattering last year’s record of $72.05. Yet despite these blistering-hot prices, oil production is falling. And profits of major energy companies are plummeting as well. Meanwhile, demand is driving upward. This sounds insane, but it’s all true. Brace yourself for even higher prices in 2008!"

[Mega]

Re: Oil prices will swamp subprime as market driver

...............So what to invest in than Luke?
Mike

[Guest]

Re: Oil prices will swamp subprime as market driver

Miker -

You already know everything you need to know. Your present question is just looking for some reassurance.

Just act on what you already know. You only need to execute the investments for the very broad insights you already have. Oil will become a form of money in this next twenty years, if it is not already.

You will not see oil and gold prices move in opposite directions, at least not for very long, from here on out. However, if you believe in the finance based thesis governing resource prices, specifically oil, then predictions are more difficult and treacherous.

If you are convinced depletion of oil is real, i.e. a massive and irrevocable event on a historic scale of changes - then the signposts are easy to decipher, and quite clear even to us laymen. In a way it's a means for us to "cheat" on market wisdom, because it maps out some very high probability events.

People around here are not too convinced about the geological underpinnings of soaring oil prices as far as the eye can see - they think a global recession led by America will crater oil prices - so they will be doing a lot of work to discern the investable trends going forward. It does not have to be that complicated.

[Rajiv]

Re: Oil prices will swamp subprime as market driver

Further down in the oil drum discussion

To summarize, we know that IF gas prices at the pump rise by $1 per gallon, the public will have $150 billion less to spend on other purchases. Following Mr. Feldstein’s speech, we see that home prices would have to fall by 15% to cut consumer spending by the same $150 billion. Which of the two is more likely to happen?

That’s what we would like you to respond to.

A tricky side-note: Mr. Barnhart in his column talks about investors. We know that for home prices to cut consumer spending by $150 billion, $3 trillion in “wealth” will disappear. There doesn’t seem to be an equivalent wealth effect from oil prices.

Further, there is the overall credit crunch effect to consider -- in other words, the mortgage crisis is not the only thing! The mortgage crisis is the first domino to fall. How do the dominos stack up with rising oil prices?

[touchring]

Re: Oil prices will swamp subprime as market driver

so what should we do now? buy gold?

[c1ue]

Re: Oil prices will swamp subprime as market driver

This is an old argument.

Lukester believes, perhaps correctly, that peak cheap oil combined with the rising incomes of BRIC countries will lead to an inexorable death spiral upwards of energy and food prices.

Others for money supply inflation reasons believe gold and PMs will be the safe haven.

I've put my money in several areas: 1) outside of the US dollar and 2) in new businesses with strong pricing power

Make your own decisions.

[sunny129]

Re: Oil prices will swamp subprime as market driver

With the resettimg of ARMs begining to start and YET to peak within the next 2-3 yrs, how can it recede from the headlines? You mean the credit crisis is over!

If the consumer's spending is predicted to be reduced due to falling 'wealth' from falling home equities/foreclosure and 1% or less growth or recession is in the cards, how can oil rise with reduced demand from the west? Decoupling is a myth. Consumer spending as of last record, in the west is nearly $9.5 trillion vs 1 trillion in China and 650 billion in India! Spending based on CC/debt is an exclusive western addiction!

Tell me something I don't know. Don't chew and spit out the same stuff.:mad:

[touchring]

Re: Oil prices will swamp subprime as market driver

If the consumer's spending is predicted to be reduced due to falling 'wealth' from falling home equities/foreclosure and 1% or less growth or recession is in the cards, how can oil rise with reduced demand from the west? Decoupling is a myth. Consumer spending as of last record, in the west is nearly $9.5 trillion vs 1 trillion in China and 650 billion in India! Spending based on CC/debt is an exclusive western addiction!

Decoupling is indeed a myth, but with innovations like the $2000 car from India, the rise in oil consumption from BRIC would probably more than offset any fall from the West. Assuming that America goes into recession, by how much will oil consumption fall? 1 percent, 2 percent? Also, if peak oil predictions prove to be right, oil supply will start to fall next year, so even assuming a flat demand, prices will still remain high.

[c1ue]

Re: Oil prices will swamp subprime as market driver

Assuming that America goes into recession, by how much will oil consumption fall? 1 percent, 2 percent? Also, if peak oil predictions prove to be right, oil supply will start to fall next year, so even assuming a flat demand, prices will still remain high.

The absolute usage of gasoline in the US declined in absolute terms 13% from 1975 to 1985 as a result of the last inflation/dollar depreciation episode.

The mess back then was smaller.

The situation is further more complicated because a lot of the production of goods used by the US is no longer in the US.

Thus it is very possible, even likely, that a significant portion of the oil consumption by India and China (and Bangladesh, Vietnam, etc) is devoted toward producing goods for the United States.

It is therefore very conceivable then that a major recession, much less an actual depression, in the United States could actually reduce oil demand in those very countries supposedly supplying much of the new demand.

Thus any assumption that oil prices can go nowhere but up are dependent on several things:

1) Oil demand in developing nations like China and India is mostly organic as opposed to a function of export mercantilism.
2) Oil demand from North America will not dramatically decrease
3) Technological solution will not be found
4) Oil price increases thus far are primarily not a function of dollar depreciation

All of these assumptions could be correct, but I personally refuse to take them on faith.

[Guest]

Re: Oil prices will swamp subprime as market driver

Sunny129 -

<< Consumer spending as of last record, in the west is nearly $9.5 trillion vs 1 trillion in China and 650 billion in India! ... Tell me something I don't know. Don't chew and spit out the same stuff. :mad: >>

"Global decoupling" or "no-global-decoupling", as well as American "consumer spending" are most certainly highly incomplete, and therefore misleading data, with respect to 70%+ of global energy consumption.

A surprisingly large component of global energy consumption is non-discretionary (example - family can only keep a job in some location 30 KM away with a vehicle, which they did not previously own) - and due to 3 billion such small events, a good part of overall global "non-discretionary" energy consumption is growing worldwide each year. You overlook that "discretionary" energy consumption, e.g. the American fantasy, a Fourth of July weekend driving getaway, is a uniquely American (and minor, in percentages!) sub-set of global energy consumption.

The "consumer spending" which you think is the sole driver pushing the economic existence, let alone growth of the entire developing world, is a North American "discretionary" phenomenon. Yes, the North Americans do buy a lot of stuff from the world, but 1) they represent only 29% of global energy consumption, 2) they represent one of the most mature areas of global energy consumption, i.e. one of the least volatile to business cycles. All that's left is to decide if the weakening of their exported dollars will cripple the energy consumption occurring *everywhere else*.

Look just a little further afield beyond western anxieties that "the world" will collapse without their consumption, and you have a world where a majority of the remaining 70% of global energy consumption is occurring in places where industrialisation accelerated to produce 7% - 12% annual GDP growth rates, and stayed in that range since. That is one very, very large globasl consumption train to derail merely due to the "fatigue" of the North American consumer. Their energy consumption growth rate is massive. OK, you disagree, so let's be super conservative - Chop that consumption growth rate in half for a "global recession" which you think will be imposed upon the world by the US consumer finally caving in and you still have rates of energy consumption growth as high as average global energy consumption rates of just one or two decades ago. And these present day consumption growth rates are proceeding from a considerably larger consumption basis than two decades ago.

You suggest global oil consumption will "collapse" when North American consumers retreat economically, by using, maybe, at the very outside, 15% less petroleum energy nationally through a recession? What's 15% of their 29% share of global petroleum use expressed in global terms? That's maybe 4.5% of global energy consumption. Compared to the developing world's energy consumption, which has been rising 3%- 7% per year for many years now? That's barely a speed bump.

Meanwhile, non-OPEC petroleum production declined 9% last year. Remember, non-OPEC production is the majority share of global production - it's 60% of total production! This is a massive shortfall number. If this rate of decline is repeated for another two years, you don't merely have a trend, you have a trend in net global production terms that is *massive*. A lot of private sector and government global forecasting entities now begin to see the glimmerings of what's shaping up - they see this collision of two very large, implacable trends approaching at speed. 70% of global energy consumption consists of the very rawest, most vigorous, essential energy consumption growth in all the rest of the world.

To get an idea of how preposterous the US consumer-driven global "demand destruction" notion looks, when extrapolated to these non-US segments of the world, picture this - an entire family using a single Honda 150 cc motorcycle as their sole means of motorized transport. Now multiply that same family (multiplied by 3 billion or more) moving a tiny inch up the economic ladder, to having a motorized vehicle with four wheels, that can actually carry more than jusrt one or two of those family members! This is not "discretionary transport or fuel use" - it's the entire family's primary means to improve their income! Now multiply that event by a billion and you'll get what's happening in half the world. This kind of growth in energy consumption is at the very bottom rung of the ladder - it is the rudest, crudest, most essential energy consumption growth. It's the consumption growth that is the most difficult to halt or destroy, because it's the single most important link for poor families climbing one tiny rung up the ladder to gain a vehicle that can facilitate their growing a family income just slightly higher! How "discretionary" do you think they find this idea, when a car expands their viable employment radius from 3 miles walk away, to 50 miles easy drive away?

There is a massive conceit in the West, that when the consumer in North America stops buying trinkets from the manufacturing countries, all this raw, most basic consumption growth that is gripping 70% of the world outside North America will simply bow down before the fatigue of the North American consumer! Pardon me for observing this Sunny129, and I offer this observation respectfully, but to me this seems like culturally ego-centric rubbish. These people getting a first vehicle to just inch one tiny step up in their family's earnings capability will not be denied by the "fatigue" of our heroic US consumer. Consumption growth in the entire developing world is now a pandora's box which has been opened - you can't put it back into the box - it will grow inexorably from here on out, global recession be damned.

This is the massive trend that has been let loose - and it's occurring precisely as we read data showing non-OPEC oil production declined 9% in one year? And OPEC production growth is now stagnant? You can have your "short petroleum" thesis - I could not imagine a better way to throw my investing money away than backing that theory, and i think people who buy into that are missing the biggest issue that's going to grab the twenty first century by the throat and shake it half senseless - like a wolf with a feeble rabbit in it's jaws. Pardon my vehemence on this topic - but I firmly believe you are missing a *very large* emerging issue here.

[c1ue]

Re: Oil prices will swamp subprime as market driver

Lukester,

Where do you obtain your 29% of global energy usage numbers?

Is this taking into account the manufacturing of products and commodities which wind up being used in North America? Anywhere from steel to toys?

Please provide documentation as opposed to lots of text.

[touchring]

Re: Oil prices will swamp subprime as market driver

How about the other point that OPEC purposely reduces output to keep oil prices high? Is Saudi Arabia keeping prices high to put pressure on America, like with regards to Iran?

[Rajiv]

Re: Oil prices will swamp subprime as market driver

The numbers come from

North America –
The Energy Picture II

prepared by

North American Energy Working Group
Security and Prosperity Partnership
Energy Picture Experts Group

January 2006

And they just reflect the primary petroleum consumption. If you include secondary energy usage by other countries on behalf of the US consumers, the total energy consumption would probably be in the region of 35 to 40% of total world usage.